Dueling Retirement Plans

How to handle contributions to multiple nest eggs, inheritance issues and disability payments

By

Karen Damato

Updated Feb. 20, 2010 12:01 a.m. ET

I have been rehired part-time by the university from which I retired. As a university employee, I have been able to contribute to my 403(b) plan. However, I have also been doing outside consulting work and will file a Schedule C with my tax return. Am I able to contribute to my IRA/SEP based on my Schedule C income (not university income) or am I unable to make a contribution because I am participating in the 403(b) plan?

KENNETH A. POLSE

Piedmont, Calif.

ENLARGE

Sergio Ruzzier

The Journal Report

With these two sources of income, you can participate in the university's 403(b) retirement plan and also put some of your self-employment earnings into a plan such as a SEP (Simplified Employee Pension) IRA. "You can have a separate retirement plan at each place of employment...provided the employers are not related companies," says
Natalie Choate,
an attorney with Nutter McClennen & Fish LLP in Boston. In your case, the university and you are the employers.

Participating in two retirement plans is also an option for many people who contribute to a 401(k) plan at a corporate job and also have income from a sideline business.

A SEP IRA is a popular choice for the self-employed. You can open and contribute to a plan for 2009 up until your tax filing deadline, including extensions. You can contribute up to 20% of your net earnings from self-employment, up to a maximum contribution of $49,000 a year in 2009 and 2010.

Contributions are deductible as a business expense; you'll owe tax on that money and any investment earnings upon withdrawal.

My mother passed away in September, and my father, age 85, wants me, his son (61 and the only surviving child), to inherit his IRA portfolio. However, we both want his four grandchildren to inherit part of the IRA portfolio as well. The distribution would be 60% to me and 10% each to the four grandchildren. How can we take advantage of the currently available tax rules to delay Uncle Sam's day of reckoning?

ED ZWIRN

Huntingdon Valley, Pa.

ENLARGE

Sergio Ruzzier

Your dad can file a beneficiary designation form for the IRA that specifies the five beneficiaries (you and the four grandchildren), along with the percentage intended for each, says Ms. Choate.

With an arrangement like this, the beneficiaries would have about a year after the IRA owner's death to get the inherited IRA divided into separate inherited IRAs, she says, and "any sophisticated and knowledgeable IRA provider" should be able to handle that request. Each beneficiary would then be able to spread out withdrawals based on his or her life expectancy, delaying the tax bite.

Ms. Choate recommends taking extra care and having the IRA owner's estate-planning lawyer prepare the beneficiary-designation form. It should cover various contingencies, such as changing the percentages if a beneficiary should die before the IRA owner, or if more grandchildren are born, she explains. And if any of the intended beneficiaries are minors, it might be desirable to set up trusts to receive their shares.

I currently receive monthly disability payments from three sources: a private policy that I have had for 24 years, all premiums paid by me; an employer-sponsored group disability plan, all premiums paid by me; and lastly, monthly Social Security benefits.

Are any or all of these payments subject to federal and state income tax?

JIM LAYMAN

Wallingford, Conn.

ENLARGE

Sergio Ruzzier

When it comes to disability coverage purchased from insurers, "the key...is whether you paid for it with after-tax dollars," says
Bill Fleming,
a managing director in the Hartford, Conn., office of accountants PricewaterhouseCoopers. If that's the case, then the benefits are tax-free at the U.S. level, and also in Connecticut, which generally follows the same approach as the federal tax system.

Your private policy clearly qualifies; the employer-sponsored coverage does as well—as long as you didn't pay for it with pre-tax dollars as part of your company's benefit plan.

As a general rule, Mr. Fleming advises people to pay for disability coverage with after-tax dollars, in order to increase the value of those benefits if they ever need to collect them.

Social Security disability income—like other Social Security benefits—can be taxable or not, depending on your income. For federal purposes, up to 85% of Social Security income can be taxable. On 2009 returns, a single taxpayer may owe tax on those benefits if half his Social Security income and all his other income, including tax-exempt interest, exceeds $25,000. The threshold for couples filing jointly is $32,000.

If some of your Social Security income is taxable for federal purposes, it may or may not also be taxable in Connecticut, depending on your income and filing status. Complete the "Social Security Benefit Adjustment Worksheet" in your state tax package.

—Encore welcomes your questions at encore@wsj.com. Ms. Damato is a news editor for The Wall Street Journal in South Brunswick, N.J.

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